Trends: Dangerous Illusion

Submitted by Lon Jefferies on Friday, April 10, 2015 - 9:00am
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Focusing on market trends is a foolish way to invest – essentially betting that what has done well will continue to thrive. A new book from financial guru Tony Robbins, for instance, looks to the past to plan for the future. We all love, even need, predictability. But depending too much on what’s come before in the markets can turn your portfolio into a train speeding toward a wreck.

The psychological basis for this kind of investing is called recency bias, the bad habit of assuming that recent financial trends will continue well.

For example, last year the Standard & Poor’s 500 (large-capitalization U.S. stocks) returned 13.69%, including dividends, significantly outperforming small-cap and international equities. Sounds great, and now you might think it smart, if not plain common sense, to load your portfolio with the big 2014 winner.

Purchasing the asset category that recently did well frequently amounts to buying something overvalued or at least about to suffer a drop in value. Consider the S&P 500’s year so far: around 1.57% average returns on 2015. The index iShares MSCI EAFE (an exchange-traded fund tracking the stocks from developed nations outside North America), a big loser last year, is returning 7.64% so far this year.

Pop financial coach Robbins recently published MONEY Master the Game: 7 Simple Steps to Financial Freedom, a book that falls prey to an increasingly popular version of the bias. Robbins worked with famous hedge fund manager Ray Dalio to create the “All Weather” investment strategy, designed to perform well across all investing environments. The asset allocation for the strategy: 30% stocks; 40% long-term bonds; 15% intermediate-term bonds; 7.5% gold; and 7.5% commodities.

In this case, Dalio constructed his model portfolio by looking at historical trends, not just the past few months. No matter. As the phrase goes, past performance is no guarantee of future results.

As Robbins points out, the All Weather did well during the last 30 years. From 1984 through 2013, this portfolio averaged an annual return of 9.7%, achieved a positive return in 86% of the calendar years and never suffered more than a minus-3.9% return during a calendar year. Not bad.

The results reflect only the past 30 years, though, as it happens the strongest bull bond market in history. Your assuming that bonds will enjoy an equally strong showing through 2045 is questionable at best – and destructive at worst.

Analysis of longer times shows more trouble. As investment analyst Ben Carlson points out, the same All Weather portfolio hypothetically returned only 5.8% annually from 1928 to 1983.

It’s not that MONEY isn’t worthwhile or that All Weather is a poor tool. All of seven of the book’s steps are sound financial practices: learning to invest in your future, keeping investment fees low, setting realistic goals for rate of return, diversifying and creating a retirement plan. The All Weather portfolio may also work well for investors who don’t need much return to achieve retirement goals and who want to minimize risk.

My point: Avoid recency bias. You invite catastrophe, for instance, if you just assume you’ll enjoy a 9.7% annual return during retirement if you use the All Weather portfolio. What happens if the historic bond rally fades or you don’t plan ahead for losses?

Depend on no one tool and no one trend. Always be aware of the tendency to give too much credence to recent market moves; don’t let those moves sway and hurt your long-term investment strategy.

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Lon Jefferies, CFP, MBA, is an investment advisor with the fee-only financial planning firm Net Worth Advisory Group in Sandy, Utah. You can find Lon on Twitter, LinkedIn and Google+. Contact him at (801) 566-0740 or

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